If Covid-19 has taught us anything, it’s that many of us have a tendency to act impulsively and without getting the facts. The ridiculous rush to collect as much toilet paper as possible when things started to get to boiling point in March is a typical example. Before then, toilet paper was just another item on your standard monthly shopping list, but certainly not the only thing.
Pretty much the same can be said for offshore investments. Many people don’t even consider an offshore investment as part of their investment needs until the rand takes a nosedive, and then, without proper research or expert advice, they invest impulsively without giving any thought to the products and currencies they choose.
Why should I invest offshore?
The reality is that an offshore investment should always be on your investment to-do list, and the main reason for this is diversification, both by asset class and currency.
In terms of currency, the benefits are quite obvious: to protect yourself against the depreciation of the rand. Sadly, as South Africans, we are quite familiar with political instability, though this is not unique to South Africa. Add to this, amongst others, inflation and interest rate concerns, and bad perceptions about the country and you have a recipe for rand volatility. By diversifying your investments across the currencies of a number of developed countries, you should benefit from the rand’s decline in value over the longer term.
Another aspect to consider is that certain factors that affect certain sectors, are fairly unique to South Africa. When we consider the local banking sector, for example, it’s affected by elements such as interest rates, risk and local consumers’ levels of indebtedness. This causes the local banking sector to often behave quite differently to its offshore counterparts. Therefore, by investing in similar sectors offshore, you will essentially gain exposure to all the relevant industry sectors with their accompanying levels of risk, returns and business cycles.
Furthermore, the tax clearance process has become much simpler, and individuals may now invest up to R1 million offshore without obtaining a tax clearance certificate, and up to R10 million with tax clearance.
There are countless opinions on what the optimum amount to invest offshore is. This mainly depends on the level of risk you are willing and able to take, along with what you can afford to invest offshore.
You can also consider the impact of exchange rates on your living expenses. For example, are exchange rates likely to affect the cost of running your motor vehicle and/or do you travel overseas regularly? If so, you should invest offshore at least to the extent that you want to hedge against prices that will rise as a result of currency depreciations.
The truth is that South African asset classes in general, relative to their international peers, are performing poorly, with none of the local asset classes (local shares, bonds or property shares) having been able to outperform local money market over the past five years (until the end of April 2020).
It is for this exact reason that more and more financial advisers are encouraging their clients to invest literally all of their capital offshore. But the fact is that our local market hasn’t always performed this poorly. If we look at the data to our disposal since the end of 2000, you will see that in rand-terms, the MSCI All Country World Index (ACWI) has grown by 9.7% per year (until 30 April 2020), while the FTSE/JSE All Share Index (JSE) has grown by 13.3% per year. If you had invested 100% of your capital in the ACWI, your investment would have underperformed inflation 31% of the time over a 60-month (or five-year) rolling period.
Regulation 28 of the South African Pension Funds Act, however, restricts offshore exposure to 30% currently.
Things looked much rosier for investors who invested their capital 50/50 in each of the above indices, which would have delivered returns of 11.7% per year, but more importantly, only would have underperformed inflation 4.6% of the time over a five-year rolling period over this period.
Foreign versus rand-denominated
You can invest offshore either by buying and using foreign currency, or by using rands.
If you opt for foreign currency, you will be limited to your annual offshore investment allowance (which includes monetary gifts, travel, maintenance, study and donations to missionaries), and minimum investments may be considerable. Your money, however, will be truly offshore, enabling you to invest in whatever you like in any country you want. Your returns are also paid in the currency of your choice, which you can leave offshore for as long as you choose.
When opting for a rand-denominated foreign investment, you can invest rands in products offered by a local financial services company, which, in turn, invests the money on your behalf in foreign investment opportunities. Your capital and your returns are paid in rands in South Africa. You can invest any amount you like and any amount the product provider is prepared to accept. Minimum investment amounts tend to be much less than investing directly offshore in foreign currency, therefore making it more accessible to investors, and you are not bound by an annual offshore allowance.
Which product should I choose?
You have an abundance of choices, from offshore unit trust funds, to ETFs, to direct shares. Although a broad-based global managed fund, general equity funds will suffice for most investors, I will always recommend that you seek expert advice before choosing your offshore products, and also consider the estate planning considerations before you start – since the way you choose to invest could impact your estate, should you die. Experts employ dedicated research teams that thoroughly analyse offshore companies and funds and base their choices on fundamental factors such as historical performance, balance sheets, current economic influences and future prospects.
When investing in a rand-denominated investment, tax is relatively uncomplicated as you are taxed in the same way as you would be taxed on a local investment. That means that you will pay capital gains tax on the value between the initial investment and the end value of your investment. The gain will therefore also include any depreciation in the currency. The tax on this will be payable in South Africa.
When investing in offshore funds or shares the capital gains will be determined in the foreign currency. The gains are then converted into rands which means you are not taxed on the devaluation of the currency. Estate duty with direct offshore investments may be more complicated, due to things like Situs taxes that has the potential to increase estate duty payable considerably. Again, it is advisable to consult your financial adviser or tax specialist prior to investing offshore, especially in terms of the tax implications of such an investment.
The world is filled with scamsters just waiting to take advantage of uninformed investors and countless South Africans have fallen victim to foreign scams in the past. Pay attention to the following:
- Always make sure that you seek advice from a qualified financial adviser, preferably one with a solid background in offshore investing.
- Refrain from investing in unlisted investment companies.
- Avoid products and providers that are not registered with the Financial Services Conduct Authority (FSCA).
- Know who you are dealing with. Never conduct business solely over the phone or via email unless absolutely necessary.
- Don’t fall for promises of exceptional returns. If it sounds too good to be true, it most likely is.
- Make sure that you know exactly what you are investing in, and avoid complex products.
A compelling case for including offshore investments in your investment portfolio can certainly be made. The benefits, although not discussed in too much detail, are undeniable, as long as you do your homework properly and remember that an offshore investment should form part of a well-diversified investment portfolio.
The opinions expressed in this blog are the opinions of the writer and not necessarily those of PSG. These opinions do not constitute advice. This is intended as general information and does not form part of any financial, tax, legal or investment related advice. Although the utmost care has been taken in the research and preparation of this blog, no responsibility can be taken for actions taken based on the information contained in this blog. Since individual needs and risk profiles differ, it is always advisable to consult a qualified financial adviser before taking action.